Fundamental Elements of Business - Essay Example

It basically involves the rising funds through interests which not mount pressure on the organization. More pronounced is the fact that the cost of equity gives the business organization a sense of expression which allows the organization room to go to all ends to acquire funds. They are not restricted by debt or anything. Disadvantages of cost of equity. If a company is successful, the higher the cost of equity will definitely leave the company little. There is no stipulated cost of equity; it, therefore, depends on the interest rate which renders the company rather helpless.

In this case, the cost of equity of a company puts the organization in the position of always requiring votes from shareholders before taking certain decisions Advantages of cost of debt "wise use of debt may lower firms weighted average cost of capital (WACC) during inflation debt is repaid with 'cheap dollars'". In this case, raising debt capital is easier and less complicated because the company is not required to comply with state, federal security laws, and regulations. Disadvantages of cost of debt "Interest and principal must always be met when due regardless of a firm's financial position, also a poor use of debt may lower a firm's stock price.

It is interesting to note the fact that unlike equity debt must at some point be repaid."(Abraham M 98.) In an attempt to calculate the cost of capital for a firm -Danny's textile company. The following data represent the position and dealings of the company for a few years. PRICE20056.50%4.00%1.5%20045.20%4.00%1.00%20034.50%3.00%1.5% Now in an attempt to calculate the cost of capital for Danny's company using, first, the cost of capital. The following formula is used since you must first consider the pre-tax cost of debt which is; Risk-free rate + default spread.

Which is = 6.50% + 1.50% = 8.00% (1 - 0) = 8.00%The firm is paying no tax currently. Now cost of equity = tax free rate + default spread (4.00%) 6.50% + 1.60 (4.00%) = 12.90% Cost of debt = risk free rate + retail price (default spread) 6.50 % + 1.50 % (d. s) =8.00 Market value of debt = $ 349 mil (12%) Market value of equity $84/ share x 340.79 mil/share = $28.626mil (98.8%). Cost of capital is. = 12.9 % (.988) + 8.00 %( 1 - 0) (.012) =12.84% The above example displays the cost of capital of Danny's textile company using cost of debt and cost of equity.

However, in reaching or finding out the status of a company it is advisable to take a critical look at the following features in a company. The cash flow; which reveals a company's amount of capital involved in the running of the company and the people involved. The turnover; is a statement of the current financial position of the company. The profit a company makes over a period of time also informs a company's status of course if a company does not at the end of its year produce the amount of money it invested it's in bad shape.

Effectiveness of the management, which is the competence of the management.the ability of the management to bring in new ideas for development. The question here is - when was the last time those managers brought in a working and successful idea.